I’d like to officially welcome you investors to the second phase of my terrific series, “Buy, Fix & Stay,” which emphasizes my business philosophy that when structured the right way - owning rentals can be a fun and profitable way to build solid wealth.
In Part I of this creating wealth with Landlording series, we looked at different property types and market segments; left off by providing 6 possible acquisition sources for finding real estate deals. Now, In Part II, we’ll dig into the details of how to correctly analyze a deal, and also cover how to fund those deals. Here we go…
Ways I Analyze and Compare Investment Opportunities
At this point, I want to share with you three formulas that you can use to compare investment opportunities. (Also, I want to share with you a bit of sage advice my mentor shared with me when I was first getting started.)
Knowing how to compare different income-producing properties will be essential to your success as a buy-and-hold investor. We’ll be covering some mathematical formulas, but don’t worry, they’re simple to calculate. Once you learn how to implement them into your business, they’re going to give you the needed insight to make good buying decisions.
1) Price Per Square Foot
When investing in single-family houses, one of the most common ways of comparing multiple investment opportunities is to determine the price per square foot. This information helps to compare properties being sold at different prices that are different sizes.
For example, we have three different houses:
- One being sold for $110,000 that’s 1300 sq. ft.
- One that’s being sold for $90,000 that’s 1100 sq. ft.
- One that’s being sold for $115,000 that’s 1400 sq. ft.
Calculating the price per square footage allows us to compare and see which one is a better deal. Price per square foot is super easy to calculate. You simply take the sales price and divide it by the square footage of the home.
2) Price Per Door
Once you start venturing into multi-family properties, price per door could be used to quickly compare multiple multi-family properties. Price per door is found by dividing the purchase price by the number of units the property has.
For example if you had a four-plex priced at $75,000, you simply divide 75,000 by four. The price per door is $18,750.
To understand if this is a good price per door, do a little research and find other comparable multi-family units that have recently sold in the area and compare their per-door final prices.
I use the multiple listing system (MLS) to do my research and you can do the same if you know a real estate agent or if you become a licensed real estate agent. Also, if you know a specific property’s address you can check the county tax records to compare with your subject property.
3) Cap Rate
Capitalization rate is another method of evaluating income-producing properties. Determine the cap rate for a property by dividing the net operating income by the market value of the property.
If you have a property worth a million bucks that produces $100,000 a year in net operating income, you would have a cap rate of 10%. (By the way, net operating income is found by subtracting your fixed and variable costs from gross rental income.)
At this point, you can say to yourself, “If I paid cash for this property, I would earn 10% on my money by the end of the first year if my net operating income was accurate.” Then look at multiple deals and decide if anything else produces better than a 10% cap rate, so it’s a comparative tool.
The two main drawbacks that I have found with cap rate calculation are:
- It doesn’t take into account any debt financing that you may have on a deal, so the whole calculation becomes much more difficult once you have a money partner or you’re borrowing funds from a bank.
- It can be difficult to gather the necessary financial data to run the calculation because net operating income is not data that can be found from public records. You have to actually go and ask the owner of the property to provide it to you.
The one cool thing that cap rate can do for you is that it can help calculate how many years it takes for an investment property to pay for itself. If you take 100% and you divide it by the cap rate, it’s going to tell you how many years into the future it’s going to take for your investment to pay for itself. In this case, you would take 100% and divide it by 10% which means this particular investment will take 10 years for it to completely pay for itself.
How To Fund Landlording Deals
Conventional lending through a bank is the most common form of financing. This is one that usually comes to mind first simply because it’s the one with which we’re all familiar. The main problem is the number of hoops the average investor has to jump through just to get a loan on an investment property.
Check these out:
- Good credit is at the top of the list, which not a lot of people have – especially after the recent housing collapse
- You’ll need proof of income and assets for at least one year – possibly two years in a row
- The property you’re buying has to pass the lender’s sniff test so don’t even try to buy a major fixer-upper because it’ll never qualify
- You’ll be required to put 10% to 20% down
- Even if all these prerequisites are met, you can still qualify for a maximum of only 10 loans in your personal name
That brings us to hard money. Hard money is another form of financing, but it’s typically a short term solution accompanied by high interest rates and high fees. The main benefit to getting hard money loans is that only the value of the property is taken into account to qualify. In other words, your personal credit score is never an issue. It is considered asset-based lending.
The money is received quickly allowing you, the investor, to be able to make a quick purchasing decision. In my opinion, only, only, only (did I stress only?), only use hard money if you have a fast exit strategy. For instance, you’re flipping a house for a quick profit, or if you’re already prequalified for a rate and term refinance from a conventional lender.
Now we come to private money. I love private money. Private money is just what it sounds like. These types of loans come from someone who knows less about real estate investing than you do, but still wants to profit from investing. They’ll put up the loan in exchange for either profit participation or fixed interest return.
The best part about private money is that it’s negotiable. You and the private money lender negotiate the terms of the agreement. Show the private money lender that your plan is to cash them out from their loan after, say, six months or so by doing a conventional rate and term re-fi. You can use private money to get into rental properties, then turn around and use that same source for your next purchase.
Lastly, you can set up a joint venture or partnership. Find an investor with a lot of cash, but who has little desire to invest any dirty work into a deal. You can use your skill-set and your hard work to go out there and build a rental portfolio. Then you and your partner can split the profits. Think of this investor more as a financial friend or a money partner, while you do all the sweat equity.
Don’t Overcomplicate Landlord Investing
I want to share something with you that my mentor drove into my head when I first started in this business. He told me, “Don’t overcomplicate this business. Simply get off your butt and go out into your target market and place some boots on the ground.”
When you go out into the real world to look at properties, take all your online research with you. This is when you will see the realities of your data. So don’t be scared of the math. This business is actually quite simple. Don’t overcomplicate things. Gather your data, and then get your butt out there into the local market and put some boots on the ground.
Well, that wraps it up for Part II…
In Part III, I’m going to go into the essential docs that every landlord needs. I’ll also go into detail about the difference between self-management and hiring a professional property manager. Lastly I want to share with you my best practices for screening tenants. So stay tuned for all this important information in Part III.